Question

An expected rise in the rate of inflation for consumer goods will increase aggregate demand. Why is that? Inflation means increase in prices so wouldn’t Aggregate demand decrease as the price goes up, since consumption is reduced?

Answer 1

Expected inflation is different from current inflation. When current inflation rises, consumption demand is reduced and that is why aggregate demand is inversely related with price level or inflation. But when inflationary expectations suggest a surge in future inflation, consumers expect higher future prices of goods and services so they are encouraged to make a purchase now at a price which seems relatively lower compared to future price level. This results in stimulating the aggregate spending and so a higher expected inflation for consumer goods will increase aggregate demand.